Monday, May 5, 2014

Frances Coppola tweets about full reserve.

She asked yesterday “Please tell me what the difference is between government guaranteeing deposits, and banks being forced to back deposits with guaranteed government debt”. The answer is thus.

Where government (i.e. taxpayers) backs a bank that engages in loans to commerce and mortgagors, that’s a subsidy of those loans. And there is no excuse for subsidising loans to commerce or mortgagors. At least there is no excuse for subsidising the BANKS and DEPOSITORS who engage in those loans.

There may of course be social reasons (aka vote winning reasons???) to help mortgagors. But that’s frankly questionable in the case of people buying million or more pound houses with half million or more pound loans. Thus payments by government to those mortgagors really needs to be kept separate from banks’ mortgage funding departments which ought to be a business that stands on its own two feet. And there is certainly no excuse for subsidising loans to commerce.

As to Frances’s “banks being forced to back deposits with guaranteed government debt”, that’s a reference to full reserve banking under which where depositors want 100% safety, they have to lodge money in accounts (or in separate deposit taking entities) backed just by base money or short term government debt.

That’s a service provided by government / central bank which costs taxpayers nothing. I.e. no subsidy is involved (quite rightly).

So to summarise, Frances’s “government guaranteeing deposits” involves an unjustified subsidy. In contrast her “banks being forced to back deposits with guaranteed government debt” refers to a type of account offered by government which offers 100% safety (an attraction for some depositors), but that involves no subsidy.

The Chicago School.

Frances also tweets: “The UK had the sort of banks Simons described - pure deposit-takers investing in govt debt. They could not give the returns people wanted.”

Simons by the way is the Henry Simons of the “Chicago school” which advocated full reserve banking in the 1930s. Anyway, the answer to Frances’s above point is…

Obviously a “pure deposit-taker” or entity that simply warehouses money (rather than loans it on) can’t provide the “return that people want”.

Unfortunately what “people want” is a flagrant self-contradiction: they want to have their money loaned out so that they can earn interest, while being absolved carrying any of the risk involved in that process. So the risk is inevitably born by the taxpayer and that equals a subsidy.

Enter politicians stage left. Politicians promise voter/depositors what they want, while keeping quiet about the cost. Of course there is a massive cost: the annual TBTF subsidy, lender of last resort facilities offered to banks but not to other industries and the periodic trillion dollar bailouts of the banking industry, etc.